by the author of dead companies walking

Category Archives: spoiled americans

First off, I’d like to thank Chuck Jaffe for a great chat about Dead Companies Walking on his MoneyLife podcast. I enjoyed it. You can listen to our conversation below (or, if you are reading this on email, you can download MoneyLife’s January 28, 2015 podcast on iTunes or by clicking here):

Something extraordinary happened last week: a politician went against the dogma of his own party and proposed something that might actually boost our economy and improve our country’s long-term fiscal health.

Of course, the plan has no chance of getting a vote, let alone passing congress. And even if it did manage to pass, President Obama would veto it before his first morning cigarette. But just because Representative Dave Camp’s tax reform bill is a lost cause doesn’t mean it’s not a worthy one.

When I’m scouting dead-companies-walking, I look for a number of factors. Businesses fail for all sorts of reasons, after all. But there are almost always two main symptoms of a company in terminal condition: falling revenues and mounting debt. These twin problems feed one another and create a kind of corporate death spiral. As revenues drop, debts rise. Making matters worse, creditors begin to demand higher and higher interest rates to service that debt, which means that repaying it eats up more and more of a company’s shrinking revenues. Pretty soon, that company can’t meet its obligations and its only option is to declare bankruptcy.

I usually find comparisons between government and business strained. But with a government shutdown looming by midnight tonight and the very real possibility that the U.S. Treasury will renege on its credit obligations becoming more likely every day, Washington D.C. is starting to look like the dysfunctional boardroom of a business fast on its way to insolvency.

I’d like to expand on something I wrote near the end of my last post on the current boom in Texas. As I said, buying into or shorting secular trends is a key investment strategy for me, and Texas’ explosive growth is a major opportunity. But I don’t think most people understand why the state is doing so well. It’s not just because of its low taxes and hands-off regulatory regime. If that were the case, low-tax backwaters like Alabama and Mississippi would be thriving, too. What sets Texas apart is education, especially the public UT system, which possesses the third largest endowment in the country behind only Harvard and Yale.

Dynamic, innovative economic regions–with the highest per capita incomes–always benefit from quality educational systems. Silicon Valley and the Northeast are the most obvious examples. But other places like North Carolina’s research triangle have also been fueled by great schools. The reason for this isn’t rocket science. You simply can’t have sustained economic growth without a steady supply of smart, highly educated people.

The problem is that schools cost a lot of money. And most states these days–especially the state where I live, California–spend far more on prisoners, public employees, and old people than education. It’s a disturbing secular trend, so disturbing that if California were a stock, I’d short it.

A few years back economists Kenneth Rogoff and Carmen Reinhart claimed that countries with high debt loads suffered slow growth rates. Their research was used to justify draconian spending cuts in Europe. But it turns out Rogoff and Reinhart flubbed their numbers in a big way, and Keynesians like Paul Krugman have been having a grand old time gloating over it. But just because Roghoff and Reinhart were wrong doesn’t mean Krugman is right.

Every year, we spend more than a trillion dollars more than we take in. That’s a dire situation. But how we’re spending that borrowed money is the real crime. In short, old people are killing us. That’s right, I said it: if we don’t do something soon, grandma and grandpa are going to bleed us dry.

With the horrible events in Boston earlier this week, and in Texas last night, it seems like I should talk about something pleasant and diversionary today. So how about a post on, oh I don’t know … taxes?

On Sunday, the Times ran a couple of columns on the horrors of our tax code. One piece focused on the code’s unfairness, and how working people often wind up paying higher tax rates than hedge fund managers like me. Another documented how hopelessly complicated the code is, noting that Americans spend 9.14 billion hours filling out IRS forms every year. These twin critiques are not new. I’m old enough to remember when then-presidential candidate Jimmy Carter called the tax code “a disgrace to the human race.” And yet, Carter and every other would-be reformer after him have failed to make taxes fairer or simpler. If anything, the code has gotten both more complex and less equitable since Carter left office. Why is that?

"[Scott Fearon's] insights on the common ways that mature companies often doom themselves apply equally well to start-ups. Every business, young or old, needs to avoid the ... mistakes that he outlines."

About the Author

Scott Fearon has spent thirty years in the financial services industry.
Since 1991, Scott has managed a hedge fund in Northern California that invests in fast-growing companies with little or no Wall Street coverage while shorting the stocks of distressed businesses on their way bankruptcy.